Source: Guojun Overseas Macro Research
Author: Zhan Chunli
Guotai Junan believes that with Trump coming back to power, inflation factors and weakening US dollar credit may become the key to supporting the continued strengthening of gold. Long-term risk may come from the breakthrough development of the US AI industry: if the US can use the AI wave to achieve reindustrialization and significantly increase total factor productivity, it will effectively ease inflation and fiscal pressure, thereby slowing the weakening trend of US dollar credit, which may become a key variable in blocking the gold bull market.
Gold's pricing system is based on its unique dual attributes. Gold has the dual properties of currency and precious metal. As a monetary attribute, its supply is relatively rigid and unaffected by sovereign credit expansion; as a precious metal attribute, it is widely accepted as “hard currency” worldwide. This dual attribute makes gold show anti-inflation and credit risk resistant characteristics in its relationship with the US dollar, while giving it a natural safe-haven function.
Based on this, we believe that the gold pricing framework is mainly composed of three core dimensions: inflation effect, fiscal credit, and risk factors. Specifically, the inflation effect is reflected in the relative appreciation of gold when the dollar's domestic purchasing power declines; the fiscal credit dimension reflects the significant positive correlation between gold prices and the US federal deficit rate. Continued fiscal expansion may trigger a “de-dollarization” process and increase the allocation value of gold; risk factors mainly stem from safe-haven needs driven by uncertain events such as geopolitical conflicts and social unrest.
The paradigm shift in the relationship between gold prices and interest rates reflects macroeconomic structural changes. Since the beginning of the year, gold has performed excellently among major asset classes with an increase of over 26%. Under the traditional theoretical framework, the price of gold is mainly driven by holding costs, showing a significant negative correlation with the real interest rate on ten-year US bonds. However, since the Federal Reserve began its interest rate hike cycle in 2022, this negative correlation has been significantly reversed, and the current price of gold has clearly exceeded the theoretical level implied by real interest rates. We believe that this trend essentially reflects the structural impact of the accelerated transformation of the macroeconomic paradigm in the post-pandemic era, and that the traditional gold pricing model may be re-calibrated.
Demand for risk hedging and the transformation of the dollar credit system are reshaping the gold pricing mechanism.
First, under the new paradigm of rising inflation and heightened geopolitical tension, the systematic allocation value of gold as a safe-haven asset has increased markedly. Especially in the context of the ongoing Russian-Ukrainian conflict and the turbulent situation in the Middle East, the market's acceptance of gold's safe-haven attributes has further increased.
Second, anti-globalization trends and the process of definancialization are driving the evolution of the international monetary system towards multipolarization. Combined with the continued rise in the size of US debt, the US dollar's position as a reserve currency has weakened relatively. During this transition period, gold is expected to become the core carrier of physical asset flows and establish a key position in the multipolar monetary system. This trend is fully confirmed by central bank behavior: in 2022 and 2023, global central banks made net purchases of 1,135 tons and 1,100 tons of gold, respectively. As of May 2024, the central bank of China had increased its gold reserves for 18 consecutive months. The continuation of the central bank's demand for gold purchases highlights countries' new understanding of the strategic allocation value of gold, and has become one of the core factors supporting the price of gold.
In summary, resilience to risks and the weakening of the US dollar credit system are essential reasons for gold's outstanding performance since this year.
Recently, the negative correlation between US bond yields and gold prices has returned. Last week, the dust of the US election fell, and market transactions all revolved around “Trump 2.0,” which was extremely beneficial to US stocks and the US dollar. The yield on US Treasury bonds also remained high. As of this Wednesday, the 10-year yield on US bonds remained above 4.400%. However, as for the price of gold, which has been rising for a year, it has fallen in response. Since November, the price of spot gold has fallen from a high of 2,790.070 US dollars/ounce to around 2,600 US dollars/ounce as of this Wednesday.
We believe that the current decline in gold prices reflects a return to the inverse relationship between gold prices and US Treasury yields. Under normal circumstances, US Treasury bonds, like gold, also have a safe-haven effect, so they have a competitive relationship with gold. Furthermore, rising US Treasury yields are often optimistic about the economic outlook or declining risk aversion in the market. Under such circumstances, it is also bad for gold. An important reason for the strong performance of gold in 2024 is the continuous improvement of its safe-haven properties in a global context. The important reason behind this is that the Russian-Ukrainian conflict has not stopped. After Trump comes to power, it will greatly facilitate the easing of the Russian-Ukrainian conflict. Therefore, this is an important reason for the return of the inverse relationship between US bond interest rates and gold prices.
“Trump 2.0,” what is the subsequent trend of gold?
Combining the three factors (risk factors, inflation effects, and fiscal credit) that we mentioned earlier, we believe that the main factor affecting the trend of gold in the short term is the safe-haven factor of global capital, because the Russian-Ukrainian conflict is expected to ease, and the pressure on safe-haven funds to flow to gold has plummeted. Moreover, the US economy is expected to strengthen, which will also increase capital risk appetite and reduce safe-haven demand. However, in the medium to long term, with Trump coming back to power, inflation factors and credit factors will become the key to supporting the continued strengthening of gold.
First, gold is used as a hedge against inflation. Theoretically, expectations of re-inflation caused by “Trump 2.0” will benefit gold in the long term. Second, from the perspective of fiscal credit, gold is more resistant to national credit risk than the US dollar. Expectations of tax cuts and fiscal deficits created by “Trump 2.0” will increase the credit risk of US debt to some extent. Continued fiscal expansion and rising deficits may overdraft the dollar's credit. Based on the above reasons, the macroeconomic factors of “Trump 2.0” will not reduce the favorable factors of gold prices in the medium to long term.
We believe that gold has a definite medium- to long-term allocation value. What we think is worth paying attention to is that long-term risks may come from the breakthrough development of the US AI industry: if the US can use the AI wave to achieve reindustrialization and significantly increase total factor productivity, it will effectively ease inflation and fiscal pressure, thereby slowing the weakening trend of US dollar credit, which may become a key variable in blocking the gold bull market.
Editor/jayden